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Veteran banker Uday Kotak said allowing 100 percent foreign investment in Indian banks is “not a great idea”.

India should be getting foreign investment from a position of strength and not of weakness, the vice chairman and managing director of Kotak Mahindra Bank told BloombergQuint’s Menaka Doshi on the sidelines of the World Economic Forum at Davos, Switzerland.

If a foreign bank wants to have a wholly owned subsidiary to do business in India, that’s fine....And then there are Indian private sector banks. We should stop calling them Indian private sector banks because not much is left...

Uday Kotak, VC & MD, Kotak Mahindra Bank

Prime Minister Narendra Modi’s administration is holding talks to raise the foreign investment limit in private sector banks to 100 percent from 74 percent, and to 49 percent from 20 percent in state-run banks, the Business Standard newspaper reported citing a government official it didn’t identify.

Enhancing India’s Competitiveness

While India must stay away from protectionism, it needs to find ways to stay competitive, he said. Pointing to the country’s “consistently poor” current account, the billionaire banker said the country must take lessons from major economies like China, Japan and Germany with strong trade and commerce-led investment.

Even when oil was $40 per barrel, we had a current account deficit. This year, we will run a 2 percent current account deficit. India has managed the debt side of this deficit very conservatively but in the bargain, we have been excessively dependent on foreign investment to finance what is effectively a P&L loss item.

Investment Cycle Turnaround

Kotak expects the private investment cycle to turn in the next two financial years as consumer demand goes up and capacity utilisation improves. The nature of private capital itself will change over the next few years, the billionaire banker said.

“A lot of it will be institutional capital, including private equity capital. Not the traditional promoter capital in every case. There are a few strong promoters who will put money to work.”

India In A ‘Sweet Spot’

The country is in a sweet spot, with growth reasonably sustainable as long as oil prices don’t go out of whack, Kotak said. He expects the country to grow at 7 percent in the financial year ending March 2019. The economy bounced back in the quarter ended October after five straight quarters of decline in growth though advance estimates released by the government suggest India may grow at 6.5 percent in the ongoing financial year—the slowest pace since 2014.

Some fiscal slippage may be likely this year at 3.4-3.5 percent of the gross domestic product, he said. The government in the upcoming Budget can use the flexibility of divestment in public sector units to keep the deficit in check, Kotak said.

Indian Markets In Bubble Territory?

With the structural improvement in the economy and after the twin shocks of demonetisation and the Goods and Services Tax, a lot of first-time savers are entering the equity markets. Kotak cautions against this shift towards financial savings ending up in a “narrow pipe of 100 companies”.

If some of this money goes into small- and mid-cap companies where governance may not be at the same level, what happens, should something change? And how do we respond from a policy point of view to ensure that we build something which nurtures these savers for the long haul to create a sustainable long-term capital market of India.

Uday Kotak, VC & MD, Kotak Mahindra Bank

Watch the full interview here.

Here are edited excerpts from the conversation:

How are we to read the economy today?

The economy is improving, and we can see it on ground. We can see a change of pulse in our loan growth. I believe that India will grow at 7 percent in 2018-19. I’m quite comfortable with the fact that the Indian economy is steadily recovering. It is reasonably sustainable as long as oil prices don’t go out of control. Thus India is in a sweet spot. If there is an area we need to focus on, it is on India’s competitiveness. We don’t need to be protectionist, but we must figure out how to be competitive. Even when oil was at $40 per barrel, we were running a current account deficit. This year we will be running a 2 percent current account deficit and I’m of the view that India has managed the debt side of financing this deficit very conservatively. But in the bargain, we have become excessively dependent on foreign investment to finance what is effectively a P&L item. We should be getting foreign investment from a position of strength and not of weakness. If you look at some of the major countries in the world, like China, Japan and Germany, they have emerged as global powers with very strong trade and commerce, and investment is pouring in because of that. The only exception to the rule has been the U.S., but then they have the reserve currency.

Do you think the growth in Indian economy will continue to be driven by consumer demand?

As demand goes up, it starts asking for capacity, which will inevitably lead to an investment cycle. The year 2018-19 will see a pickup in the investment cycle as people become clearer about the political outcome in 2019. In fact, both FY19 and FY20 will see a pickup in investment, as a lot of people are already doing brownfield. There is improvement in capacity utilisation and India is looking at a turnaround.

Will we probably never see private capital going ahead?

We will most likely see private capital in a different form. We will see a lot of it come in as institutional capital, including private equity and other sources of capital, not the traditional promoters’ capital in every case. There are a few strong promoters who will put money to work. Therefore, we will see a different mix of new investments in the next few years. The fundamental structural story is also changing in the private sector.

Do you think Arun Jaitley has any space for anything but a prudent budget?

My sense is that the government will have the flexibility of public sector undertakings to ensure that the government’s fiscal deficit is under control. They will use the disinvestment tool appropriately to contain the fiscal deficit. I think there will be a little bit of a slippage, but not too much, say around 3.4 to 3.5 percent of GDP this year, but the government has significant ability in its underlying public-sector undertakings to keep the deficit under control even next year.

How concerned are you about where we are right now with respect to interest rates? Do you expect the cycle to move up?

We are going to have to watch the inflation levels, which is why investment must start, because we will soon have issues on capacity. The investment cycle needs to pick up now to ensure that inflation remains under check.

At these rates?

I see the 10-year at around 7.25-7.5 percent for the next few months, but these are fast changing.

Do you expect rates to move up henceforth?

You have to watch for it, I think the RBI rate cycle is flat to up.

Can you give us an idea on how much of an opportunity the stressed assets business brings for Kotak Mahindra?

The opportunity is significant, and it is just beginning to unfold. You’ve got Rs 12 lakh crore size of business there, so you should pick and choose wisely. You have to take it step by step.

How are you planning to go about it?

We’ve got many opportunities, between our bank, alternate assets business and investment in ARC. We’ve got a team looking at various opportunities.

In an interview with the Indian Express, you “we got some of our jewels majority foreign-owned.” Is this just an observation or an objection?

It’s an observation about a policy framework in practice for the last 30-40 years. We’ve consistently had a weak current account that reflects poor competitiveness on trade by the country. There are two options to fill the current account - debt or equity. The policymakers, including the RBI have been conservative on taking debt to fund the current account, and in the bargain take foreign investment to fill the hole. I am open to welcoming foreign investment, but not from a position of weakness.

When you hear the possibility of banks raising the FDI cap to 100 percent, do you feel it’s much more of the same thing that you are talking about or do do you feel enthused?

If a foreign bank wants to have a wholly owned subsidiary to do business in India, that’s fine. If you look at the Indian banking sector, there are public sector banks, which have challenges, and then you have the Indian private sector banks. I think we should stop calling them ‘Indian’ private sector banks, because not much is left...

So, is 100 percent FDI in Indian banks a good idea or a bad one?

It’s not a great idea.

Is there a risk of bubble in mid cap and small cap companies?

Firstly, the Indian economy is structurally doing better, that should reflect in valuations. But post demonetisation and the Goods and Services Tax rollout, we are seeing first time savers in equity mutual funds and insurance policies like ULIPs. These first-time savers do not understand the underlying risks they are taking, and a lot of money is moving to financial savings like at the top of a funnel, from where it’s moving into a narrow pipe of a few hundred companies. So, it is bound to lead to some level of exuberance. Most of these savers have not seen the kind of volatility that we’ve lived through in our lives. We must be clear on what happens if some of this money goes into small and mid-cap companies where the governance may not be at the same levels. How do we respond from a policy point of view to ensure that we build something which nurtures these savers for the long haul to build a sustainable long-term capital market for India? Finally, for the first time we’re seeing the ability to create a strong capital market where both domestic and global players can play. And the concern is to nurture this.

Do you think the markets are overvalued?

I think it’s company specific, some of the large-cap companies may deserve revaluation. What we must be clear about is that cats and dogs also run, and it’s very difficult to define what’s a cat and a dog. I can’t define that for you. But we need to have a system where governance and fair play are in place. No more WhatsApp tips for people who don’t understand..things like that.

But this will take time, right?

We have got to keep chugging away, because unless we do that, we will be running the risk of not creating an institutional framework for a long-term sustained capital market.